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University of California, Davis - Department of Agricultural and Resource Economics

October 25, 2011

Abstract:

In a well-functioning futures market, the futures price at expiration equals the price of the underlying asset. This condition failed to hold in grain markets for most of 2005-10. During this period, futures contracts expired up to 35% above the cash grain price. We develop a rational expectations model to show how non-convergence arises from a wedge between the price of storing the physical commodity and the cost of carrying the delivery instrument. This wedge is the coupon in a present value equation, so our results exemplify a significant financial market in which a present value model explains prices.